State vs. State Smackdown: How Other Courts Are Responding To California’s Unique Law ‎Prohibiting Covenants Not To Compete

In last week’s Inbox, we briefly discussed the dispute between rival insurers Aon and Alliant Insurance Services, Inc.; that lawsuit centers around Aon’s allegations that Alliant raided Aon’s top executives in violation of those employees' covenants not to compete contained within their employment agreements with Aon. That dispute is currently being fought via two parallel lawsuits brought in two different states, New York and California.

Ordinarily, the plaintiff is “master of his or her complaint,” meaning that even if a lawsuit could be brought in multiple jurisdictions, courts will typically defer to the forum chosen by the plaintiff. When parties have claims against each other but prefer different states, this doctrine often results in a so-called “race to the courthouse” in which the first party to file “wins” his or her chosen forum. The “first filed” complaint – the “winner,” if you will, then typically moves to either stay or dismiss the second-filed parallel jurisdiction in the “loser’s” state, and the “loser’s” court almost always complies. This may not be high-minded justice, but it is routine.

Or so we thought.

In the dispute between Aon and Alliant, Alliant “won” the “race to the courthouse,” filing its lawsuit in California several days before Aon filed its parallel lawsuit in New York. The departing employees who left Aon then moved to dismiss or stay Aon’s New York lawsuit, and Aon cross-moved for injunctive relief. On September 21, 2012, the trial court declined to dismiss or stay the proceedings, and ruled in Aon’s favor instead. That trial court ruling was upheld by the appellate division on January 10, 2013.

Why did the New York courts deviate from common practice awarding the first-filed plaintiff his or her choice of forum? Because in this case, California has a unique law that prohibits covenants not to compete of any kind. California Business & Professions Code § 16600 provides that “[E]very contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” In English, this means that one party can sign a contract containing a covenant not to compete, or not to solicit certain clients, and the other party is prohibited by California law from enforcing that voluntary agreement unless certain exceptions are met.

Sections §§ 16601 through 16607 set forth those exceptions, which we will discuss in more depth in a future post. Briefly: § 16601 permits the enforcement of a noncompete agreement by a purchaser of a business against the seller if the seller has sold the “goodwill of a business.” See Fillpoint, LLC v. Maas, ___ Cal.App.4th ___ (No. G045057 Aug. 24, 2012) (discussing § 16601).

Sections 16602 and 16602.5 permits the enforcement of a reasonable noncompete agreement when a partnership or LLC is dissolved or a partner or member dissociates from said partnership or LLC. Sections 16606 and 16607 offer some protection for a limited subset of customer lists. And that’s about it, unless your covenant not to compete contains a clause requiring you to purchase a “horror comic book,” id. § 16603.

The bottom line is that the effect of California’s law is to invalidate pretty much any covenant not to compete contained in virtually any contract. Of course, the gravamen of Aon’s complaint is that Alliant poached its employees in violation of covenants not to compete contained in the employees’ contracts of employment. Moreover, the employment contract with Aon specified that all disputes thereto would be governed by Illinois law – not New York or California law – and Illinois law permits reasonable covenants not to compete.

Ordinarily, this would mean that even a California court sitting over the Aon/Alliant dispute would apply Illinois law to the case rather than California’s own laws (which would presumably result in dismissing the lawsuit). Nevertheless, Aon successfully persuaded two New York courts that a California judge might strike down the agreement under the California law. Calling the California lawsuit “a preemptive measure undertaken to gain a tactical advantage so as to negate the force and effect of the restrictive covenants, which the parties had freely agreed upon,” Slip Op. at 32, the New York appellate court refused to relinquish jurisdiction over Aon’s claims.

Presumably, Aon will now move to stay or dismiss the California proceeding, even though that case was filed first. If neither court gives ground, the parties could be facing the unpleasant situation where two separate finders of fact are looking at the same issues at the same time, which can create all sorts of havoc.

We will, of course, continue to watch and keep you posted as to any developments.